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China's New Cybersecurity Law Smacks the Internet Giants

Local companies in China enjoy an advantage, but that advantage can also be a double-edged sword…

There are many potential pitfalls for operating in China. Local businesses can gain and maintain a competitive edge resulting from the quagmire of government regulations and local bureaucracy, which in many cases favors Chinese companies over foreign competitors. But even that advantage can be both a blessing and a curse.

Regulations can also be much stricter in the world's most populous country while providing little in the way of guidelines when it comes to implementing these rules. Those that run afoul of them can find themselves facing the wrath of regulators and on the receiving end of harsh penalties, or they can find themselves shut down entirely.

In August, China's top internet regulator, the Cyberspace Administration of China, notified the country's three largest social-media operators that they were being investigated for violating China's cybersecurity law. Tencent Holdings Limited(NASDAQOTH:TCEHY), Sina Corporation(NASDAQ:SINA) and its subsidiary Weibo Corporation(NASDAQ:WB), and Baidu, Inc.(NASDAQ:BIDU) were notified late last month that they would be fined under the law for failing to police their users.

Operating a business in China can be a blessing or a curse. Image source: Getty Images.

Clamping down

Chinese officials enacted the new law last year, marking the first set of comprehensive rules aimed at internet operators -- though, they were not clearly defined -- and imposing certain legal obligations regarding data storage, personal information, and dissemination of content.

Earlier this year, the Ministry of Industry and Information Technology acknowledged the rapid adoption of internet use and services and pointed out that there were "signs of disorderly development" that urgently needed to be rectified. The regulator immediately implemented a "nationwide clean-up of the Internet."

Policing content

Social-media outlets in the U.S. and abroad are charged with controlling a variety of negative content, including hate speech, racist or terrorist propaganda, and other banned content. The same is true of China but to a much greater extent.

The Chinese government regulator accused the three companies of failing to properly police users social media platforms, allowing them to "spread information of violence and terror, false rumors (fake news), pornography, and other information that jeopardizes national security, public safety, and social order."

The government authority imposed the maximum penalty allowed under the new regulation on Sina's Weibo, Tencent's WeChat, and Baidu's Tieba. While regulators didn't divulge the amount of the fines, the maximum penalty under the law could be as much as 500,000 yuan, or about $75,000.

Small change

These penalties don't amount to much, considering how much these companies made in the most recent quarter:

Company

Revenue

Net Income

Tencent

$15.67 billion

$4.83 billion

Baidu

$3.079 billion

$651 million

Sina

$358.9 million

$23.4 million

Weibo

$253.4 million

$73.5 million

Data from each company's financial reports and SEC filings for most recent quarter.

That said, companies don't want to find themselves on the wrong side of the law in China. Earlier this year, Chinese censors conducted a test that targeted random websites and shut them down without warning. A video streaming company reported that its website and app went dark for more than 20 minutes.

The drill was coordinated with the country's internet providers as a practice session for shutting down sites that regulators deemed problematic. These internet data centers conducted the exercise under orders from censors as part of an "emergency response" drill.

While this may have merely been a test, it does illustrate the risk these companies take, and the strict adherence to rules the government requires. The fines may have been relatively small, but they aren't the only tool at regulators' disposal.

Danny Vena owns shares of Baidu. The Motley Fool owns shares of and recommends Baidu. The Motley Fool recommends Sina and Weibo. The Motley Fool has a disclosure policy.

Author

Daniel W. Vena, CPA, CGMA is long-term investor searching for intangibles that provide explosive growth opportunities in his investments. He served on active duty with the US Army and has a Bachelors degree in accounting.
Follow @dannyvena